In the world of value investing, which fundamentally concerns itself with securities trading at a large discount to indicated or intrinsic value (the Margin of Safety), one thing investors are always on the look out for is the value trap. A value trap is a company that looks really cheap but turns out to be cheap for a reason, ie, it’s actually fairly valued at its present price. Companies in general become mispriced for a variety of reasons, and while value traps are no different in this regard, one reason stands far above others in generating its unfair share of value traps– bad management.

This essay will explore in greater detail the genesis of bad management value traps via the principle that “corporate value is a function of owner agency.” Companies with bad management tend to demonstrate the least owner agency, sometimes approaching an effective zero. As of the present, the principle of owner agency can be explored across separate 8 sub-domains pertaining to the company’s corporate governance standards.

The 8 Sub-domains of Corporate Governance

Whether a company realizes it or not, it can and must make a decision about its corporate governance policy in at least 8 different areas which affect owner agency and thus corporate value:

The Board of Directors

Company purpose

Communication standards

Capitalization/capital structure

Reporting

Fairness

Competence

Barriers

Each of these sub-domains and the choices involved will be explored below. At the end, we will summarize the “official positions” with regards to what good corporate governance looks like in light of the theory promulgated in this essay.

The Board of Directors

In a company with a diversified ownership structure, the Board of Directors exists to represent shareholders and direct the behavior of management according to their wishes. In other words, the BoD is the primary tool of agency for shareholders of the company who, without official titles or positions of management themselves, have no direct way to influence the conduct of the company, its strategy or policies as owning individuals. The BoD is similar to a “house of representatives” in an elected republic– the representatives exist to serve not their own interests, or the government’s interests, but the interests of the individual voters who put them into power.

The BoD should have broad authority to put in place an overall competitive strategy for the company (what do we make or sell? how do we do it? who do we compete with?) and to hire and fire key, C-level managers (CEO, CFO, COO, corporate comptroller or treasurer). These managers should be fully “answerable” to the BoD and thus, the shareholders, whose property they are responsible for utilizing and safeguarding in the course of business.

In modern public companies, it is common for these top managers to be represented on the board, for example, the CEO is also often the chairman of the BoD and presides over its affairs. This is an enormous conflict of interest, because the CEO can not hold himself accountable as a member of the board, and the purpose of the board is to be influenced by the shareholders, not the hired management. This is especially problematic when the CEO is not a substantial shareholder himself.

Another common state of affairs in public companies is that the BoD does not represent significant shareholders. Individuals legally important stakes (5%+) or significant economic stakes (10-25%) often do not get offered representation on the boards of the companies they own and sometimes nominally control due to the distribution of share ownership in a company. If the Board of Directors doesn’t include individuals who represent the interests of shareholders, it serves no purpose other than to rubber-stamp the initiatives of the management, which means it serves no purpose at all besides the propaganda value of pretending the company has functioning corporate governance through the existence of a Board of Directors.

Company purpose

Why do companies exist?

Historically, companies were formed for the benefit of their owners in order to turn a profit. Some of the first joint stock companies were engaged in material manufacture or entrepreneurial discovery of new lands and trading routes. Long pre-dating formal joint stock companies of Europe in the early 1500s were numerous merchant combines across cultures and the ages which were formed to pool risk in long-distance hauling of cargoes. Because the owners were the only people who put capital into the company, it was the owners who were the only people expecting to derive a direct benefit from the operation of the company in so far as it generated profits– the agents of the company might earn salary and bonus according to the terms of their employment contract, and of course the prevalent State often wished to interest itself via tax, but otherwise the issue was pretty cut and dry.

The modern era has brought with it many innovations in the area of an answer to that question, but none of them seem to be any good. Today we hear talk of “stakeholders”, where a stakeholder seems to be any economic or political interest, such as customers, communities, employees, vendors, foreign nationals, labor unions, governments, etc. who isn’t an actual equity owner in the company. We hear of “corporate social responsibility” (CSR) which is just another way to plead the case of certain “stakeholders” with regards to the deployment of a company’s capital. In vogue since the late 1980s and still popular today is the idea that long-serving management of the company should be the real beneficiaries of the existence of the company and that they should accumulate a lion’s share of the value the company creates because of the key role they play in making the company capital fecund in the first place.

Yes, it seems today that companies exist to serve everyone but those who own them.

Regardless of the answer to this question, it is important to simply have an answer. It becomes a standard of value that a company’s management and employees can be held to in observing their choices and behavior. It can serve to answer the simple question, “Are they doing a good job?” from which many other questions and decisions might emanate.

Without a stated purpose, it is not only impossible to agree to where everyone is going but it is impossible to govern the corporation so that it gets there. Certain purposes exclude certain ends and certain methods while allowing certain others.

Communication standards

With regards to how the company and the Board of Directors communicates with shareholders, there are also certain standards that can be implemented to guide action.

A common policy seemingly in place at many companies is clubsmanship and secrecy– executive management is unwilling to provide basic answers to shareholder questions and requests for information, often going so far as to put up unnecessary obstacles to proving they are in fact a shareholder in the first place. And the Board of Directors, captured by the management, facilitate this by refusing to assist the shareholders in their requests, to bring pressure upon management to provide the information (legally) requested and often times they will even make themselves unavailable or unresponsive to shareholders entirely.

The opposite pole would look like this: the management of the company assumes a goodwill posture and provides answers to any (legal) information request made. If the company is of sufficient size and scale and it is fielding a lot of such requests, it may make a special individual (such as an IR agent) available to help source answers. It might also look for a scalable solution, by putting commonly requested corporate documents (financial statements, records of ownership, minutes from board meetings, etc.) into the public domain via its website, and to also offer an FAQ session for answers to repeated inquiries.

As such information is legally due to shareholders anyway and can’t really harm the company by being shared, it makes sense to offer it to anyone who asks, shareholder, potential shareholder or simply a curious stranger. It is not a redacted espionage memo and it doesn’t require any special classification system or hierarchy of security clearances to access.

The Board can facilitate this process as well by being in regular contact with larger shareholders to understand their needs and concerns for the company they own, and to communicate these thoughts to management in board meetings and report back their findings to shareholders in the process.

Capitalization/capital structure

Public companies are in a unique position in terms of their ability to raise capital and finance their projects. Because of their public nature, it is a relatively simple affair to do a rights offering and issue new shares, debt or other securities. Even more important, if ever the market treats the company unfairly, they have the opportunity to buy back their shares from concerned shareholders at a discount to intrinsic value. The company is always in a better position when it is owned by people who believe in the vision and direction of the company, which can be achieved by buying back shares from those “distressed” sellers who have lost confidence.

One role of the BoD and corporate governance is to determine what the best capital structure is at any given time in a company’s life given its future plans and strategies. This means making high level decisions about the debt to equity ratio, if applicable, and also about the issuance or buyback of shares more generally.

Another thing the BoD can facilitate as an act of corporate governance is being efficient with the company’s capital– dividending it out when the company has more capital than projects, and issuing rights to bring capital back in when it has more profitable projects than it has capital to deploy on them.

This is not a one-time decision. It is something a company should be examining on a periodic basis– either quarterly, annually, or any time a major change in its market price or project pipeline occurs. Companies that hoard capital they don’t need do their investors a disservice because they forgo the economic returns available on the surplus capital, which could be deployed at higher rates of return in other enterprises. And companies that refuse to expand the share base in response to important project opportunities make a similar mistake but inverse.

Reporting

Markets move on information. Without information about a company, investors are left with nothing to make a decision off of and so they can not act rationally. They become forced to gamble and speculate. For a company that is not in a hyped industry, the gamble is often made in fear– shareholders sell out at any price to avoid association with a “black box.” It is a critical aspect of corporate governance to have a consistent reporting policy in place to update shareholders on the performance of the company’s strategy over time and to explain key financial data to them.

This kind of reporting requires: transparency, honesty and articulate capabilities. The chairman, being the head of the Board of Directors which represents the shareholders, is the most likely individual to communicate with shareholders about the state of their company. He might append letters from the CEO and other key executives as well if he so desires, but each of these individuals has an incentive to patronize their reader and focus on what went well. The chairman, having no duty to anyone but the shareholders and reality, is in a better position to see the whole hog and not just the lipstick on the pig.

For reporting to be meaningful, it must take into consideration the entire strategy and how the operations worked to achieve it or fail it. Glossy PR brochures highlighting the charity and good works of the management or employees, of the high level successes that did not translate to the bottom line, or to a stylized, marketing view of the company and its operations that does not drive to the key objectives and how they were met or missed, do not do shareholders any good.

While it’s true that the annual report is a key “marketing” piece in attracting knowledgeable shareholders, its primary purpose is to inform, not to sell. It must focus on the good, the bad and the ugly, not the positive or the bright side.

Fairness

Tied up in the ideas of representation and company purpose is the idea of fairness– are all shareholders treated equally? And are all managers and employees treated the same with regards to their duties to the shareholders?

There are two separate but related concepts of fairness at stake. One is the fairness of decisions between majority and minority shareholders, aka, “taking minority capital hostage.” The other is the fairness of decisions between shareholders and agents of the company, aka, “being subservient to loyalty or tradition.”

It is a sadly common sin amongst many public companies with decisive majority owners, especially owners who are insiders and part of management, that they find ways to employ the company’s capital or govern the company which benefit them at the expense of the passive, minority shareholders. An example of this would be a majority shareholder who is also a manager, who is earning an outsize salary and delivering a subpar return on equity compared to the industry or market, who refuses to “fire” themselves as a manager or scale back their pay. The minority shareholders are in effect subsidizing this poor performance with their capital, which is trapped in the company controlled by the majority shareholder.

This is not “fair” because it doesn’t treat the minority and majority shareholders as economic equals– the majority shareholder enjoys a special benefit or subsidy that the minority shareholder pays for. If the company did not exist, and this arrangement was being proposed as a condition of forming the company, no rational minority shareholder would agree to it. If they wouldn’t agree to it de novo, they can’t be thought of as agreeing to it as part of a going concern. This would be similar in a political system where some citizens are treated as “second class” by the law and discriminated against to the advantage of the privileged class.

The other sin amongst public companies is holding on to operating units or employees or managers who are underperforming in their jobs by some agreed upon, objective standards. These units are typically retained out of a sense of tradition (“We’re an X company, we’ll always be an X company”) or personal loyalty (“Y has been with the company for so many years, we can’t put them out on the street now”). Clearly, these kinds of decisions could easily conflict with a stated purpose such as “To maximize profits to shareholders.” They again represent subsidy. And the fact is that no company has infinite resources or can afford to engage in charity without limit; and if it can’t afford without limit, it can’t afford WITH limits, as the economic consequences are the same– the company is wasting capital on ineffective means.

Adhering to loyalty or tradition at the expense of shareholders means turning the business into a charity. Charity is a private virtue and a public vice and it has no place in a public company in this sense.

Competence

Modern companies are complex organizations with extensive economic resources at their command. The average public company, regardless of market price, has millions to tens of millions of dollars of shareholder capital involved in ongoing operations. There is too much to keep track of, and too much at stake, for a company to allow incompetent people to manage this level of responsibility.

Corporate governance serves another function here in setting standards of value for managers and employees in terms of the competence required in their positions of relative responsibility. Importantly, the Board of Directors can set standards in specific areas, such as financial or economic concepts which have an important bearing on the company’s risk position or the stability and profitability of its operations over time. Internal capital allocation, that is, the determination of how to deploy the company’s capital (buybacks, dividends, the raising of finance, or the investing of capital into operations or liquidating of capital so employed), is a seemingly simple discipline which nonetheless has a magnified impact on the company’s operations and its wealth as a whole– it requires a specific level of competence in the basic concepts and dilemmas involved for a person to add value. Many companies are run by people who do not understand capital allocation, have never studied the issues involved and often aren’t even aware of the momentous decisions they are making with regards to it, instead letting personal prejudice or momentary whim be the arbiter of decisions costing millions of dollars with long-lasting consequences for the company into the uncertain and unknowable future.

The Board of Directors can strongly influence the competence of the company and its management by researching and instituting relevant standards of competence needed in key decision-making areas and working to educate and provide resources to the company’s agents employed in these areas.

Barriers

In economic and business literature the concept of “competitive advantage” often revolves around a related concept of “moats”. A moat is a barrier to entry in a competitive market that preserves the value of incumbent firms by allowing them to spend resources on deploying their business model rather than spending those resources on defending it from competitors looking to do the same.

In the world of corporate governance, a similar phenomenon exists: “shareholder defense” tactics aimed at preventing “takeovers.” However, there is a subtle difference in the nature and virtue of each.

In the business competition sense, moats which provide competitive advantage usually exist as a structural part of the industry– they are embedded in the nature of the economic activity itself or the incentives competitors would face that are innate to margin structure, human behavior, etc. They usually can not be constructed or developed purposefully. Not so with takeover defenses. These are things that a company can or can not choose to employ and which the law often gives power to, implicitly or explicitly.

Competitive advantages protect companies from other companies. But shareholder defense mechanisms do not protect shareholders from other investors– they protect managers from their shareholders!

The actual effect of takeover defense mechanisms, when employed, is to drive a wedge between the people who own the company (the shareholders) and the people who control it (the management) by limiting the authority and control the shareholders have over dismissing or countermanding the management’s decisions.

Staggered boards, for example, help to ensure that change at the board level happens slowly (if at all), rather than as quickly as shareholder ownership changes. If there are 5 board seats and all are held by “insiders” and only 2 come up for bid every few years, then it may be 6 or more years, for example, for a shareholder who manages to obtain a majority of shares of the company to see his majority influence reflected in the composition of the board. That means a long period of time where existing management can work against the shareholder or at cross-purposes.

Poison pills, another common strategy, work to similar effect. A poison pill provision essentially neuters the voting power of a shareholder who manages to accumulate a substantial fraction of the company’s outstanding shares. If the provision says that any shares owned over 10% will vote at 10%, it prevents any specific shareholder from obtaining voting control, which protects the management from being told to change their tune or from being thrown out entirely.

It seems counter-intuitive, but removing barriers to entry for ownership of the firm is an important piece of corporate governance policy to work out. And much like the popular theory of democratic politics or republicanism, reserving the “right to vote” or the legitimate authority of the voters over their political appointees results in a situation where the appointees behave irresponsibly and often build up power and prestige at the expense of the people they were hired to represent.

“Official Positions” of Good Corporate Governance

Outlined below is an attempt at an “official” good corporate governance doctrine that any concerned company, its Board and shareholders could adopt to improve the corporate governance situation at the company. In so doing, it is believed that the company will attract quality, long-term oriented shareholders willing to pay a fair price for a properly managed and profitable enterprise. The items elaborated on below serve to maximize owner agency and with corporate value being a function of that agency, they should also serve the maximize the value of the company.

The board of directors should represent — meaning, be constituted of — significant shareholders and/or their agents

The company should be run for the purpose of maximizing the present value of expected cash flows to shareholders

There should be a constant dialog at the board level which includes larger shareholders about the best way to achieve the stated purpose

When the opportunity for capital/equity is low, money should flow out of the company; share buybacks and dividends are the way for money to flow out; when the opportunity is high, capital should flow back in; a rights offering (with transferable rights) is the cheapest and fairest way for money to flow back in

The annual report should have an essay or letter by the chairman (who is ultimately responsible for achieving the stated purpose) reiterating the objective, discussing the level of achievement in the prior year and outlining the strategy that has been agreed upon to pursue it going forward

It is unfair for a majority or manager to retain employees or operations for sentimental reasons unless they satisfy the purpose of maximizing the present value of expected cash flows to shareholders

Anyone responsible for achieving the objective should have the necessary grounding in finance and economics to understand how to carry the work out (study an agreed upon bibliography)

Management/corporate “shareholder defense”/takeover defense mechanisms such as staggered boards, poison pills, limits on shareholder meetings and proposals, secrecy/lack of disclosure, etc., destroy shareholder value by driving a wedge between ownership and control

I have the privilege of attending the Stanford d.school’s Design Thinking Bootcamp, an opportunity I was turned on to by a friend in the venture capital community. In preparation for the program, attendees were asked to conduct an “Ideation” session at their place of work with other managers and decision-makers in their organization. This is an opportunity to not only get an introduction to the attitudes and tools used in design thinking, but also to begin practicing with these ideas immediately within one’s business as part of the design thinking meta is “a bias toward action.”

Here are some takeaways about thinking creatively and generating ideas in a collaborative environment that I’ve gained so far:

Adopt a “Yes, and…” Attitude

First generate, then evaluate

Don’t just find one idea

Think in terms of a specific problem

Focus on emotions

Use constraints to increase idea volume

Use analogous thinking to go some place else

Use “QBD” to evaluate ideas

Think about the “headline”, not the “article”

If it doesn’t get written down, it didn’t happen

More details on each of these ideas, and impressions from my actual ideation sessions, follow:

Adopt a “Yes, and…” Attitude

When people come together to create ideas, they have a habit of seeking to find what is wrong with their collaborators thinking, rather than what is right. The goal in design thinking is to first come up with a lot of ideas, not to find the “right” idea as quickly as possible. A helpful attitude to adopt is “Yes, and…” which means, whenever your collaborators come up with an idea, reply “Yes, and…” and then build off of their idea, either with an additional flourish or iteration, or with another idea you have in mind that their idea has led you to think. Don’t try to make yourself look smart, try to make your partners look brilliant.

First generate, then evaluate

Another intuitive habit most people bring with them to creative sessions is to try to evaluate ideas as fast as they’re generated. No sooner does someone have a new idea than does that person, or a collaborator, try to figure out if the idea “fits” with the constraints of the project. Many ideas that are either excellent on their own, or could lead to an excellent and realizable idea, are tossed out in the instant evaluation before they’ve had a chance to make an impact. Get in the habit of separating the generation of ideas and the thinking through the merits of the ideas generated. Never confuse the two or allow the processes to mingle in your thoughts or practice.

Don’t just find one idea

When you’ve got a problem, you only need ONE solution. And ultimately, you can only implement one solution– time, resources, etc. are scarce. So it’s easy to think the goal is to “just come up with one idea.” But trying to find the right idea means evaluating as you generate, and it also means pre-qualifying your own thinking before you even generate ideas. Your goal in ideation is actually to generate as many ideas as you can, regardless of whether they make sense, actually solve your problem, are feasible, etc. Go for quantity, not quality, when generating ideas.

Think in terms of a specific problem

It helps to come up with ideas when your problem is specific enough to be solved by an idea you come up with. This means thinking in terms of a specific group of people and in terms of a specific change you want to bring about, either an action or a state of mind. A prompt that can help is to frame your problem with this ad lib– “What can we create for… [specific group of people] that makes them/that helps them [choose one] … [a physical action you want them to take, or a state of mind you want them to adopt]?” An example would be, “What can we create for 10 to 12 year old kids that makes them excited to eat vegetables?” The problem is specific– it is about 10 to 12 year old kids, a group of people with distinct qualities. And what the solution provides is also specific– it will generate a feeling of excitement in them in relation to their eating vegetables.

Focus on emotions

You’ve got your problem. It’s important to think of the mental state of the “user” you’re solving for. Almost inevitably, finding a solution will involve focusing on the change in the mental state that is necessary to motivate action. Sometimes, the change in the mental state by itself is the goal, for example, “What can we create for customers who are angry with us that will make them love us and tell all their friends?” Translating the problem during the ideation process into an emotional state creates a valuable constraint (discussed below) for increasing idea volume.

Use constraints to increase idea volume

It is counterintuitive, but putting constraints on your idea process actually allows you to be even more creative because it focuses the mind in specific ways. Some constraints used as examples in the ideation workshop were “Every idea must cost $1 million” or “Every idea must get you in trouble with your boss”. Imagine you actually have a budget constraint– you only have $50,000 to spend on a solution. Coming with the REAL budget as a constraint is likely to limit your thinking because you’ll immediately begin pre-qualifying and evaluating ideas as you try to generate them.

But if you invert the real constraint into an imaginary one where you must SPEND a large sum of money on your idea as a minimum, you will end up with a sense of much more freedom. Later, you can take those high dollar ideas and figure out how to reduce the cost to something that is actually affordable. The inversion process allows you to hurdle over your real constraint which would limit your creativity and therefore your ability to find a real solution.

You could think of arbitrary constraints, simply to inspire creative and offbeat thinking, or you could try inverting real constraints to trick yourself into thinking past them. The d.school profs use the metaphor of the thumb over the garden hose, which forces high pressure jets of water to spray over a larger area versus just using the innate pressure of the hose which tends to dribble out.

Use analogous thinking to go some place else

Another tool for successful ideation is to create analogous situations and imagine how those people or institutions would handle the creation of a solution for your problem. To find analogies, you translate your problem into the emotional state, mentioned earlier. Sometimes it’s easy and obvious, because you already have an emotional change as a condition of your solution. But if you don’t, this can take some creativity in and of itself to figure out what the emotion is you’re searching for. As an example, if your problem was “What can we create for our hiring department that helps them to only hire people who exceed our standards?” the emotional state might be “confidence.”

Once you have your emotional state, you must ask yourself, “What kind of person, group or place is superb at generating this kind of emotion?” Once you have a list of such entities that excel at generating this emotion, you can do an iterative process of asking yourself, “What would X create for… that helps them/that makes them…?”

Now you are in someone else’s shoes, thinking about the world the way they do and you have unlocked an entirely different form of creativity from your own.

Use “QBD” to evaluate ideas

Okay, you’ve got a ton of ideas at this point. Now it’s (finally) time to evaluate them. But you’re not just going to start deciding which are possible and which are insane. Instead, you’re going to use more creativity to evaluate your ideas. You’re going to think about which ideas are Quick, Breakthrough or Delightful.

Quick ideas may not be full or perfect solutions, but they could be reasonably implemented right away and this incremental progress would have an immediate impact– things would get better as far as your problem is concerned. This is an important way of thinking about selecting solutions because often no solution is found in search of a holistic or perfect one, which either doesn’t exist or can’t be accessed in a linear way of thinking. By selecting a Quick solution, you can take steps toward what might be a final, perfect solution and get a win in the meantime.

Breakthrough ideas might not work, but if they did, they’d be a game changer. They’d be an all new way of solving the problem, or they’d give the group who employs them a distinct competitive advantage, or greatly leverage their efforts. Breakthrough ideas help us think about how to shift paradigms and find solutions that don’t just work, but work insanely well.

Delightful ideas are just that– if we implement them, people feel GREAT. And feeling great is an important part of solving problems and making progress in our work or business. When we find Delightful ideas, we find ways to inspire, motivate and energize people that can lead to other creativity or effectiveness that we can’t imagine or anticipate in simply solving the problem.

Think about the “headline”, not the “article”

When generating and sharing ideas, it’s important to think and communicate in terms of the big impact, high level concept of the idea and not get bogged down in the nitty gritty details– that way lies the habit of criticizing, condemning and evaluating before a good idea can take root, or inspire another. The instructors refer to this as thinking about the “headline” and not the “article.” An example would be, “Hire an expert interviewer” versus “Find a person with X years of experience interviewing people, pay them $Y per year, assign them duties of A, B and C, they will report to Z and will be measured in their performance by E, F and G.” You can find any number of things in the article version that might be unrealistic or impractical, if you can even come up with all the necessary details. It is putting the cart before the horse. You first have to come up with the big idea and see how it could lead to a Quick, Breakthrough or Delightful improvement for your problem, and then you can go about fleshing it out and figuring out how to make it practically work.

If it doesn’t get written down, it didn’t happen

This idea is a good practice for any meeting or information-sharing activity of any kind but it seems to be especially relevant to the process of ideation– if you aren’t writing ideas down as you’re coming up with them, they may as well not exist. By the end of a 1hr long ideation session, you might have come up with fifty or sixty different ideas and concepts as a team. Who can remember what those were by the end of it? So it is important to write them down as you go. The instructors recommend using sticky notes and slapping them on the wall as you go, which not only serves to keep things written down and makes it easy to move ideas around as you review and ideate, but the small amount of space necessarily forces one to think in “headline” terms.

Another thing that should be written down, repeatedly, is the prompt of the problem you are trying to solve (“What can we create for…?”) as well as the specific constraints, analogies, etc., that you are bringing to bear on them as you focus your ideation in different ways.

Our experience with ideation as a team

My ideation workshop involved 5 other people in our organization in addition to myself, all group managers or individuals with lead authority at the operating unit level. We split up into 2 teams of three to work through our ideation process.

One takeaway is that collaborative idea generation is FUN. We genuinely had a good time working together to come up with solutions to our organization’s problems. There was a lot of laughter, spirited talking and debate and enthusiasm. Often times a team would race ahead with a prompt or keep working after designated time was up because they were so caught up in their thinking and idea generation.

Another takeaway is that anyone can be creative. Most of the operating managers were selected because they tend to experiment and try new things in their operations, but what really makes them excellent in their roles is that they relentlessly stick to a proven system of processes and procedures. There may have been some fear that people who are really good enforcing a set of orders might not be able to come up with creative new ideas. This just wasn’t the case. They all had a ton of ideas and I think one thing that was clear by the end of the session was that everyone would’ve liked to have selected their individual problem they brought to the group for ideation work when we could only pick one at a time.

A third takeaway is that the trail one follows to arrive at workable solutions often starts in an unpredictable and highly abstract place. It highlighted for us the value of every idea generated, and the importance of separating generation from evaluation. Where you start is rarely where you will end and if you can embrace the idea of accepting all ideas as valuable and disregarding their merit or feasibility at the outset, you can let those ideas unlock all kinds of interesting solutions you otherwise may not have accessed.

Finally, we realized that even when we came up with an idea that we thought was Breakthrough or Delightful, but lacked obvious practical application, we could begin “trimming” and paring down the idea from there to find something we COULD do with it that still tapped into the essence or principle of the original idea. For example, one group came up with the idea of hiring a professional athlete to be a motivational coach to our organization’s managers. We don’t have the budget for that, nor is that athlete necessarily available for hire, but we can think about what kind of qualities we believe he would bring to such a role and look for a person we could hire that can bring those qualities, or the way we could change processes or definitions of roles within the organization to incorporate those values we now realize are essential to helping us solve a known problem. I think of this as “analogizing from the analogy”.

I can see how the ideation process, which we are just being introduced to through this practice work, can add value for all people at all levels of responsibility within our organization. It is inspiring and motivating, it creates the “bias towards action” in the person doing it and it yields real results which can actually make things better for us, our customers and our team. I am sold!

[amazon text=The First Tycoon: The Epic Life of Cornelius Vanderbilt&asin=1400031745]

by T.J. Stiles, published 2010

How and why did Cornelius Vanderbilt, steamship and railroad entrepreneur, become America’s “first tycoon” and in the process earn a fortune worth an estimated $100M in the 1870s? The simplest answer provided by this lengthy biography is that Vanderbilt was able to think about abstract entities such as corporations as representing competitive business opportunities in an age when most other people controlling them thought of them as profitable grants of privilege from the State (which they were). The result was that Vanderbilt thought strategically about his acquisitions in the sense of actively seeking to own things with identifiable competitive advantages (the best route, the lowest operating costs, network effects) which he would then exploit while slashing prices, while his competitors were stuck playing defense until they gave up and offered to buy him out in self-defense.

But the book really doesn’t offer enough specific and concrete evidence to validate this thesis, it’s really just a hunch and an attempt to read between the lines of what is offered. Like most biographers and historians, Stiles consistently fluctuates between the two extremes of failing to provide the necessary evidence to actually understand what was happening and why, and forcing a tortured narrative metaphor of “the capitalist as king/general” that ends up just confusing the issues. Vanderbilt is constantly in “rate wars”, is “battling” for control of companies and finds himself with an “empire” after yet another “conquest.” But we never hear this language in Vanderbilt’s own quotations (based upon written correspondence, newspaper interviews and courtroom testimony) which are numerous.

How Vanderbilt saw himself as a businessman and operator, and how Stiles chooses to depict him with his jarring anachronistic fadism are even more incongruous because Stiles himself spends much of the time arguing against his own descriptions! It is a puzzling choice. Perhaps books about old tyme capitalists don’t sell well without a not so subtle nod to the villainous Robber Baron laying in wait inside of all of them, but it’s a shame because the much more interesting story would’ve been the one told through Vanderbilt’s own eyes. Not to mention the fact that the Robber Baron myth is a lie perpetrated against Vanderbilt, not because he was a horrible monopolist but because he was such a pain in the ass to the horrible monopolists!

[The NYT] attacked him for, as he wrote elsewhere, “driving too sharp a competition” [… deriding] “competition for competition’s sake; competition which crowds out legitimate enterprises… or imposes tribute upon them” [… and called on] “our mercantile community to look the curse of competition fully in the face.”

Similarly, there are constant references to “the world Vanderbilt helped make” with reference to markets and businesses, the city of New York and the emergent nation of the United States of America. And while certainly the man’s actions and decisions were influential and impactful, Vanderbilt was not a statesman and never saw himself as anything more than an ambitious private citizen. There is not one example in the book of Vanderbilt plotting to remake the world in his own image. This is just another forced biographical trope that dopey readers, editors and authors seem to think makes a story ten times better to insist upon when the world just doesn’t have that many psychopaths in fact.

Other information missing from the story that seems essential to charting Vanderbilt’s rise: what he paid for various business assets and how he financed them, what he earned from them and what he paid in taxes, when he controlled an asset and when he was a minority partner, etc. Especially, we should like to know his leverage over time and how he was able to benefit from the various money panics that occurred repeatedly throughout his business career. One thing is for certain, he seemed to always be a buyer in such scenarios, never a seller, and he seemed comfortable being in control of his investments and making and enforcing operating policy, rather than being a mere financial speculator such as a partner like Daniel Drew might.

There are many charming bits of early American social and business vernacular we learn sprinkled throughout the book and its strength is in providing so many direct quotations from primary sources, especially the business media of the day, which really help to flavor the narrative and transport the reader to the place and time described. But this can also be a weakness, when the author ends up name-dropping a litany of capitalists involved in some deal or scheme and dribbling their worries and anxieties from private correspondence over several pages as the deal unfolds. I found it difficult to follow and mostly tuned out what I assume are supposed to be the action-packed moments of the story.

I first read this book shortly after it was published in 2010. I since decided to re-read it and while I wish I had had a bit more energy and focus when I did, I am glad of it. I took a new and different appreciation from some of the book’s events than I did on first pass, which suggests I’ve either improved my mental framework or at least changed it in meaningful ways over the last 7 years. Vanderbilt still comes across as a unique and heroic figure, a true titanic will. The narrative is as confused and cluttered as ever, and while I think there were the makings of a better, more concisely argued book here, and the author certainly has done his research, I am not convinced he did the right research or even fully understood what lessons he was taking away from it. The result is I’ve since downgraded the value of this particular work in my mind and think it belongs to a pretty standard class of historical biographies. Vanderbilt the man himself though is easily a five out of five as far as members of humanity are concerned!

I’ve got far more I’d be willing and able to discuss about this work and Vanderbilt as an example in private correspondence than I think I could fit into a short, coherent blog post, so really ruminating on this story will have to wait for another time and a different occasion.

This was a deep book with a ton of ideas and examples. It isn’t going to be easy for me to narrow it down to some concise takeaway, so I won’t try. This post will be more of an annotated outline of the contents of the book.

Where entrepreneurship comes from

Successful entrepreneurs are characterized by action, not inspiration. Innovations that seem big on paper may turn out to be minor businesses, while simple ideas can capture the imagination or appreciation of the marketplace in unexpected ways and scale beyond anyone’s dreams. Successful entrepreneurs are focused on creating value and making a contribution, not their potential financial returns.

There are four sources for innovation within an enterprise:

The unexpected

The incongruity

Innovation based on process need

Changes in industry structure or market structure

There are also three sources for innovation outside an enterprise:

Demographics

Changes in perception, mood or meaning

New knowledge

The unexpected

Quotes:

The unexpected success is a challenge to management’s judgment… The unexpected success is simply not seen at all. Nobody pays any attention to it… No one even looks at the areas where the company has done better than expected… It forces us to ask, What basic changes are now appropriate for this organization in the way it defines its business? Its technology? Its markets? …It must be properly featured in the information management obtains and studies… Management needs to set aside specific time in which to discuss unexpected successes. Someone should always be designated to analyze an unexpected success and to think through how it could be exploited… The unexpected failure demands that you go out, look around, and listen. Failure should always be considered a symptom of an innovative opportunity, and taken seriously as such.

Questions to ask:

What would it mean to us if we exploited it?

Where could it lead us?

What would we have to do to convert it into an opportunity?

How do we go about it?

If something unexpected happens in one’s operations, it means there is a break in the knowledge between cause and effect and it likely represents an opportunity to innovate and improve.

Incongruities

Quotes:

If the demand for a product or a service is growing steadily, its economic performance should steadily improve, too. It should be easy to be profitable in an industry with steadily rising demand… The innovation that successfully exploits an incongruity between economic realities has to be simple rather than complicated, “obvious” rather than grandiose… Behind the incongruity between actual and perceived reality, there always lies an element of intellectual arrogance, of intellectual rigor and dogmatism… No customer ever perceives himself as buying what the producer or supplier delivers… [Businesses often complain of customers who are] “irrational” or “unwilling to pay for quality.” Whenever such a complaint is heard, there is reason to assume that the values and expectations the producer or supplier holds to be real are incongruous with the actual values and expectations of customers and clients… The incongruity within a process, its rhythm or its logic, is not a very subtle matter. Users are always aware of it.

The comment about the incongruity between what a customer perceives himself to be buying versus what the producer thinks they are delivering is an aspect of Jobs To Be Done theory. The main idea there is that customers are not purchasing a product or service, but a specific solution to a task that the product or service enables them to implement. An interesting entrepreneurial opportunity is to redefine one’s business and processes in terms of JTBD to look for closer alignment to customer needs and expectations.

Industry and market changes

Indicators of industry change:

rapid growth of an industry

perception and servicing of market inappropriate due to growth

convergence of technologies that hitherto were seen as distinctly separate

Demographics

Quotes:

Demographics have major impact on what will be bought, by whom, and in what quantities.

The massive nineteenth-century migration from Europe to the Americas, both North and South, and to Australia and New Zealand, changed the economic and political geography of the world beyond recognition. It created an abundance of entrepreneurial opportunities. It made obsolete the geopolitical concepts on which European politics and military strategies had been based for several centuries. Yet it took place in a mere fifty years from the mid-1860s to 1914. Whoever disregarded it was likely to be left behind, and fast.

Static populations staying in one place for long periods of time have been the exception historically rather than the rule… It is sheer folly to disregard demographics… Demographic shifts in this century may be inherently unpredictable, yet they do have long lead times before impact, and lead times, moreover, which are predictable… What makes demographics such a rewarding opportunity for the entrepreneur is precisely its neglect by decisions makers, whether businessmen, public-service staffs, or governmental policymakers.

This unwillingness, or inability, of the experts to accept demographic realities which do not conform to what they take for granted gives the entrepreneur his opportunity. The lead times are known. The events themselves have already happened. But no one accepts them as reality, let alone as opportunity. Those who defy the conventional wisdom and accept the facts– indeed, those who go actively looking for them — can therefore expect to be left alone for quite a long time. The competitors will accept demographic reality, as a rule, only when it is already about to be replaced by a new demographic change and a new demographic reality.

For those genuinely willing to go out into the field, to look and to listen, changing demographics is both a highly productive and a highly dependable innovative opportunity.

The demographics section was one that surprised me most because demographics is something I don’t typically pay attention to, and I often find the attempt to categorize entire groups of people (“Millenials”) as behaving or valuing a certain way to be overwrought, but Drucker made sense of it for me in showing how predictable and inescapable various demographic realities are. In the broadest terms, demographics put floors and ceilings on certain aspects of market supply and demand, ie, there can only be so many people producing X, or so many people consuming Y. In more specific terms, it helps us to understand how cycles or patterns of generational growth (ie, this cohort of people is entering retirement, while this different sized one is entering adolescence) suggests where opportunities will congregate in the market space for products and services that are used by those cohorts. I think I want to try paying a lot more attention to this going forward and will investigate some demographic books I’ve heard about, such as [amazon text=Generations: The History of America’s Future&asin=0688119123].

The comment about demographics offering opportunity because it is neglected by others reminded me of Warren Buffett’s success. He possesses a deeply statistical mind and spent his childhood collecting what amounted to demographic data. He was obsessed with it. He also began investing at the cusp of the Baby Boom explosion which continued through most of his career. When he describes the reason he invested in a business like Coca-Cola, he explains it in demographic terms (X cokes a day, for Y people, with population growing at X% a year, translates to earnings of A).

This section also highlighted for me how important it is to may attention to the unique demographics of your market when hiring employees and designing customer processes. Ostensibly, if you knew a lot of your customers were of a certain age, gender, ethnic or educational background, you’d probably want to hire people like them to serve them, and design customer processes that compliment their world view. And you’d have an embedded advantage against competitors not thinking that deeply, who would look at what you’re doing and not understand why it was extra effective.

Changes in perception

Quotes:

When a change in perception takes place, the facts do not change. Their meaning does.

There is nothing more dangerous than to be premature in exploiting a change in perception. A good many of what look like changes in perception turn out to be short-lived fads.

New knowledge

Quotes:

The number of knowledge-based innovators that will survive when an industry matures and stabilizes is therefore no larger than it has traditionally been. But largely because of the emergence of a world market and of global communications, the number of entrants during the “window” period has greatly increased. When the shakeout comes, the casualty rate is therefore much higher than it used to be. And the shakeout always comes; it is inevitable.

Which ones will survive, which ones will die, and which ones will become permanently crippled– able neither to live nor to die — is unpredictable. In fact, it is futile to speculate.

This section made me think about the emergent “social media” industry, and the “blue chip” status of the FAANG stocks. These industries are too new for the shakeout to have taken place yet but it is startling indeed to think of a company with a $500B+ market cap ending up as roadkill from a future shakeup.

Principles of innovation – the do’s, the don’t, the conditions

Quotes:

All the sources of innovative opportunity should be systematically analyzed and systematically studied. The search must be done on a regular, systematic basis… [Ask] “What does this innovation have to reflect so that the people who have to use it will want to use it and see in it their opportunity?” …All effective innovations are breathtakingly simple. “This is obvious. Why didn’t I think of it?” …Effective innovations starts small. They try to do one specific thing. Otherwise, there is not enough time to make the adjustments and changes that are almost always needed for an innovation to succeed.

All strategies aimed at exploiting an innovation, must achieve leadership within a given environment. Otherwise they will simply create an opportunity for competition… Unless there is an immediate application in the present, an innovation is like the drawings in Leonardo da Vinci’s notebook– a “brilliant idea.” …When all is said and done, innovation becomes hard, focused and purposeful work making very great demands on diligence, on persistence, and on commitment.

[Ask] “Which of these opportunities fits me, fits this company, puts to work what we (or I) are good at and have shown capacity for in performance?” …[Successful entrepreneurs] are not ‘risk-takers.’ They try to define the risks they have to take and to minimize them as much as possible… Defending yesterday — that is, not innovating — is far more risky than making tomorrow… [They are] not “risk-focused” but “opportunity-focused.”

The entrepreneurial business

Quotes:

It is not size that is an impediment to entrepreneurship and innovation; it is the existing operation itself, and especially the existing successful operation… The new always looks so small, so puny, so unpromising next to the size and performance of maturity. Anything truly new that looks big is indeed to be distrusted… Entrepreneurial businesses treat entrepreneurship as a duty; if entrepreneurship and innovation do not well up in an organization, something must be stifling them. [They ask] “How can we make the organization receptive to innovation, want innovation, reach for it, work for it?” …Innovation must be part and parcel of the ordinary, the norm, if not routine.

[Ask yourself] would we now go into this product, this market, this distributive channel, this technology today? …[If you answer no, ask yourself] “What do we have to do to stop wasting resources on this product, this market, this distributive channel, this staff activity?” …Every organism needs to eliminate its waste products or else it poisons itself.

In companies that are managed for entrepreneurship, there are therefore two meetings on operating results: one to focus on the problems and one to focus on the opportunities. …”What did we do that turned out to be successful?” “How did we find the opportunity?” “What have we learned, and what entrepreneurial and innovative plans do we have in hand now?”

A member of the top management group sits down with the junior people from research, engineering, manufacturing, marketing and accounting and so on… This practice has one built-in requirement. Those who suggest anything new, or even a change in the way things are being done, whether in respect to product or process, to market or service, should be expected to go to work. They should be asked to submit, within a reasonable period, a working paper to the presiding senior and to their colleges in the sessions, in which they try to develop their idea. What would it look like if converted into reality? What in turn does the reality have to look like for the idea to make sense? What are the assumptions regarding customers and markets, and so on. How much work is needed… how much money and how many people… and how much time? And what results might be expected?

“What results do we expect from this project? When do we expect those results? When do we appraise the progress of the project so that we have control?” …For the existing business to be capable of innovation, it has to create a structure that allows people to be entrepreneurial.

In this section, Drucker argues that entrepreneurship is a culture and a practice, not a characteristic of being small, new or in a technological field. Any company can be entrepreneurial if it creates the right conditions for entrepreneurial thinking and acting, is open to entrepreneurial discoveries and treats entrepreneurship as an important, embedded business practice (much like it would treat having good accounting controls, or written customer processes).

One idea I had after reading this was to implement something like an Innovation Circle/Council within the company, a rotating and inclusive membership of line managers and staff, asking questions like:

What do you need help with? Where do you seem to get stuck or overwhelmed?

What went well that you can teach to others?

What ideas have you had recently for improving the way we do business?

Entrepreneurship in the service institution

Quotes:

Failure to attain the objectives in the quest for a “good” only means that efforts need to be redoubled. The forces of evil must be far more powerful than expected and need to be fought even harder.

For thousands of years the preachers of all sorts of religions have held forth against the “sins of the flesh.” Their success has been limited to say the least. But this is no argument as far as the preachers are concerned. It does not persuade them to devote their considerable talents to pursuits in which results may be more easily attainable. On the contrary, it only proves that their efforts need to be redoubled. Avoiding the “sins of the flesh” is clearly a “moral good”, and thus an absolute, which does not admit of any cost/benefit calculation.

It needs something that is genuinely attainable and therefore a commitment to a realistic goal, so that it can say eventually, “Our job is finished.” …If an objective has not been attained after repeated tries, one has to assume that it is the wrong one. It is not rational to consider failure a good reason for trying again and again.

A central economic problem of developed societies during the next twenty or thirty years is surely going to be capital formation; only in Japan is it still adequate for the economy’s needs. We therefore can ill afford to have activities conducted as “non-profit,” that is, as activities that devour capital rather than form it, if they can be organized as activities that form capital, as activities that make a profit.

This will date this post, but I think there are a lot of parallels in this paragraph and the problems it touches upon to what is going in the US federal government and political system with accusations of improprieties with Donald Trump. So far, no one has come up with a credible claim and evidence that Trump has done something nefarious, yet the more failures that are revealed, the more emboldened the opposition becomes that they must resist Trump and stop him before it’s too late. It’s comical.

The larger point here is that because service organizations don’t have a simple Profit/Loss acid test like a commercial business, they need some other objective KPI connected to a limited duration/scope mission they can look to to see if they’re effective.

The philosophical point in the last paragraph is also interesting. Most modern commentators would argue we have too much capital, not too little, and too much for-profit businesses and entities. The rise of “social entrepreneurship” is part of this belief that young, energetic people should devote themselves to changing the world, for free. I think they’re wrong and Drucker was prescient. But then, he studied economics and they haven’t, so that is no surprise. In fact, one of the joys of reading this book is that Drucker is one of the last great German/Viennese intellectuals of the 20th Century, which means he is widely read and knowledgeable on the subjects he opines on. That is a rarity in the 21st Century.

The new venture

Requirements:

a focus on the market

planning for cash flow and capital needs ahead of time

building a top management team long before the new venture actually needs one and long before it can actually afford one

the founding entrepreneur to decide on his or her own role, area of work and relationships

Quotes:

One cannot do market research for something genuinely new.

The new venture needs to build in systematic practices to remind itself that a “product” or a “service” is defined by the customer, not by the producer.

Growth has to be fed. Growth in a new venture demands adding financial resources rather than taking them out. Growth needs more cash and more capital. If the growing new venture shows a “profit” it is a fiction; since taxes are payable on this fiction in most countries, it creates a liability and a cash drain rather than “surplus.” The healthier a new venture and the faster it grows, the more financial feeding it requires.

“What will the venture need objectively by way of management from here on out?”

The idea of growth needing feeding, and the tax implications of realizing profitability too soon, was a challenging thing for me to read. Of course, it brings to mind the growth models of companies like Uber and Amazon. I still don’t know what to make of this. Part of me thinks if you can’t grow profitably, you aren’t really growing at all, but consuming capital and putting it on an income statement. But what Drucker is saying also makes sense in that there could be a business model that can be profitable at a meaningful scale and between then and now, it requires great investment to get there.

Entrepreneurial strategies

Quotes:

“Hitting them where they ain’t” is a strategy that involves serving markets created by pioneers which are currently being serviced poorly.

“Creaming” is a violation of elementary managerial and economic precepts. It is always punished by loss of market… “Quality” in a product or service is not what the supplier puts in. It is what the customer gets out and is willing to pay for. Customers pay only for what is of use to them and gives them value. Nothing else constitutes “quality.” …A “premium” price is always an invitation to the competition… The only way to get a higher profit margin is through lower costs. Higher prices hold an umbrella over the competitor. “Premium” prices, instead of being an occasion for joy should always be considered a threat and dangerous vulnerability.

Don’t make the mistake of maximizing versus optimizing… A benevolent monopolist cuts his prices before a competitor can cut them. And he makes his product obsolete and introduces new product before a competitor can do so.

Successful practitioners of the ecological niche take the cash and let the credit go. They wallow in their anonymity.

Price is usually almost irrelevant in the strategy of creating utility. What is truly a “service,” truly a “utility” to the customer? …What Gillette did was to price what the customer buys, namely, the shave, rather than what the manufacturer sells… It charges for what represents “value” to the customer rather than what represents “cost” to the supplier… What does the customer really buy?

One question it seems like one would want to ask when reviewing one’s operations for entrepreneurial opportunities is, “Does this represent value to our customer?” One should eliminate if the answer is no, or try to find ways to do more of that if the answer is yes.

Optimizing versus maximizing is a really interesting conundrum. It’s connected to the idea of market segmentation. When one maximizes, one is trying to satisfy every single user through the same product or service. It leads to opportunities for disruption and more appropriate market segmentation, as well as the weakening and irrelevancy of the incumbent and often the loss of the advantage that gave it its initial market position. An extreme offender in this regard speaking contemporaneously is the behavior of “luxury” auto makers like Lexus, BMW and Mercedes, who are constantly moving down-market into silly, small, over-priced offerings in an effort to make luxury more accessible. They realize they are fighting over the same limited number of actually wealthy, luxury customers, and they still want to grow their production and so they create new markets of non-luxury buyers to serve.

You have to accept the limits of your market and create a new specialized product or service to meet the needs of those outside of it. Any other path is folly. But folly is the heritage of mankind.

Thinking about service and utility in terms of the customer’s perspective, I think you could explore the idea of when the customer chooses a competitor, what are they buying from them? It’s easy to think they have just made a decision to go with a different person or group providing the same thing, but it could be more likely that they have gone with a company offering a different thing entirely, as far as they evaluate utility.

[amazon text=The Snowball: Warren Buffett and the Business of Life&asin=0553384619]

by Alice Schroeder, published 2008, 2009 (condensed and updated)

This is my second reading of The Snowball. I enjoyed it almost as much as the first, five years ago, and definitely took away different things from this reading than I did last time. At that time, I was just finishing my “personal MBA” deep-dive into value investing and was interested in Schroeder’s Buffett bio mainly for the information and insight it would yield into Buffett’s approach and track record as an investor. I was surprised to come away from that reading realizing that the book was a moral parable in the form of a man’s life (an incredibly successful, well-known and near-worshipped man) and my second journey through the book was more focused on the question “How should I think about living my life?” than the question “How should I think about investing?”

I found the book most exciting to read and most interesting personally in the exploration of Buffett’s origins and the detailed narrative about the first twenty years of the partnerships that proceeded his investment in Berkshire Hathaway. As the story wore on and it became more about managing what he had and dealing with the consequences of choices wrought long ago, I found myself losing interest, particularly as the Salomon and Long-Term Capital Management sagas carried on for a mind-numbing fifty-plus pages in total.

Buffett’s childhood was far more unusual than I cared to notice in my first reading. He was obsessed with business, investing and the impact of statistics in life not just from a young age, but in ways that were extraordinary even for someone to be described as “doing X from a young age” would imply by itself. Obsessed is not a word I use lightly here. The young Buffett was probably an odd creature to be around, even for people who loved him or found him interesting or were of unusual talent and ability themselves. This seems confirmed in later years when so many people familiar with him describe feeling exhausted after spending just a few hours with him. It helped me to realize how unfair and pointless trying to compare yourself to a person like Buffett is.

When asked by Bill Gates, Sr., at a dinner what single word they’d use to describe the outcome of their life and their success, Buffett said, “Focus.” As Schroeder describes in many places in the book, and especially at length in the final chapter, “focus” means something completely different when Buffett says it versus anyone of lesser ability and different personality. When Buffett says “focus” he means “to the exclusion of all else, with relentless, all-consuming energy, without tiring or being distracted.” There is no balance working behind the scenes. He gave up a lot of “normal” things most other people would insist on or desire in distinction to that which they were focused on, not as a sacrifice but as an inevitability of his personality.

The most obvious and tragic is his relationship with his family and his relationship with himself. Most other people who are driven towards success in their field and the monetary rewards that typically come with it offer up the excuse of their family as their motivation, honestly or not. This wasn’t the case for Buffett, and achieving supremacy in his profession and in his personal net worth really didn’t do anything to enhance his relationship with his family or the way he cared for them. It is indicated on numerous occasions what kind of tradeoff he would’ve had to make to be more involved with his family, and he never did it. It’s an excellent reminder for someone who sees themselves as driven to achieve that these tradeoffs are real and accepting a “lower rate of return” in one’s efforts is a necessary (and happy?) price to pay to maintain a relationship with one’s family, which itself is valuable.

Buffett’s relationship with himself is also instructive in this regard. Many people wonder how money can’t solve most problems, and why people who are super wealthy continue to eat poorly, exercise infrequently and maintain the same limited psychological state and insecurities they possessed before they achieved glory. The answer again is simple– in the drive toward massive wealth, things get set aside and often it is the improvement of the self as a holistic unit that is set aside first in order to claim excess in one aspect.

Of course, we can’t expect Buffett to be perfect. Nobody is, and the point of mentioning this isn’t to point out the man’s flaws, but to explain them. You can’t have Buffett and have these issues resolved to everyone’s satisfaction. They come with the territory. If you want to be “focused” like Buffett, plan on neglecting your family and yourself, quite a bit. That’s only a judgment if you think those things are objectively more important than wealth or self-actualization in the area of generating wealth. That’s not really a judgment I want to make here and I think it misses the point.

Yet, Buffett’s flaws make for a fascinating lesson in a different way. Though Buffett was unusual, and exceptional, and completely driven toward a single-minded purpose from a young age, the path was far from certain that he would need to tread to get to wherever it was that he would end up going. It’s easy to sit here today reading a book published almost ten years ago, recounting events that unfolded over the past eighty, and see what was inevitable as inevitable. But Buffett made mistakes. Many of them, along the way. That’s what’s truly remarkable, that he made mistakes and still arrived where he did. It’s a good salve for a person carrying around the perfectionist fallacy. Give it a rest and get going, you can make some mistakes and still end up alright if Buffett is any example.

I love reading stories like this, stories of flawed people of unusual ability who managed to achieve something heroic even if their life wasn’t truly ideal. I love knowing it can be done. I love knowing what the pitfalls and the tradeoffs are, so I can be mindful of them myself. I love the way I can give myself permission to not achieve what they achieved (in kind or in magnitude) having the benefit of hindsight to see what it truly took that I can’t give, or won’t.

But most of all, I just love watching someone create something from nothing. That creative energy is uniquely human and what I admire most about our species and this little project called “civilization” that we’re all tinkering away on. The Snowball is not as great an investment manual as I originally thought it was (for that, I’d recommend Buffett’s BRK shareholder letters, along with or after reading Graham’s Security Analysis and The Intelligent Investor), but it is an epic moral profile and a captivating read overall because of it.

[amazon text=Grinding It Out: The Making of McDonald’s&asin=0312929870]

by Ray Kroc, with Robert Anderson, published 1992

Reading through the stories of great entrepreneurs, business people and politicians like Cornelius Vanderbilt or Warren Buffett, it is easy to find a sentiment much like this one from Ray Kroc:

Ethel [his wife] used to complain once in a while about about the amount of time I spent away from home working. Looking back on it now, I guess it was kind of unfair. But I was driven by ambition.

I find this sentiment remarkable for a few different reasons.

The first is how common it is. It seems to suggest that achieving “great things” in a particular field of enterprise is not possible without neglecting one’s family and other personal relationships in favor of the “productive” relationships and activities.

The second is how little awareness of this tradeoff many such people seem to possess, at least until they reach the end of their life and all their glory has already been gotten. Then, as they contemplate their state of affairs, either looking back on the empire they built or ruminating regretfully now that they are deposed (violently or voluntarily), they seem to re-evaluate how they spent their time and decide they came up short in considering family time less important than it should have been. They also seem to be either disconnected from the damage they do to their children and their psyches, or else try to evade such recognition– I think Ray Kroc mentioned his daughter all of two times in this 200 page telling, and while his daughter may not have been critical to the story of building McDonald’s, you’d think she would’ve provided enough value and motivation in Kroc’s life to merit more than a couple passing mentions!

The third is how excusable such high achievers seem to find their behavior to be in retrospect. “But…” is a permission word. It negates what comes before and offers cover. Yes, Ray Kroc was unfair, but… It suggests a different moral framework for studying life or a particular circumstance, one in which the rules don’t really apply and the ends justify the means.

The fourth is what a temptation these great projects must’ve provided to these people, to ignore their family, their health or any number of other values. If I was a successful paper cup salesman but stumbled upon the idea of McDonald’s myself, could I have resisted the temptation to build it and in the process knowingly give up my family, friends, physical well-being, etc.? It is perhaps easy to sit in judgment of another person’s efforts and decisions when the attraction of my own responsibilities is relatively less compelling. It’s easy to go home to my family at the end of the day as they typically offer me more interest and excitement. But would that be the case if millions of dollars and a global business organization hung in the balance? That I don’t know for sure, and perhaps you can’t know until you’re tempted with it.

But that leads to the fifth point, which is to consider whether a story like Kroc’s and McDonald’s could be told any other way. What if in the first 27 pages of the story of this business the quote above was not to be found, nor anywhere in the 173+ pages that followed? What if Kroc didn’t get divorced (twice), didn’t have a string of health issues along the way, came home and kissed his wife and daughter on the forehead five nights a week and spent most of each month at home and around town rather than around the country? What choices would’ve needed to be made differently to support that outcome, and how would the company look different either internally or competitively if that had been the case? How big would Berkshire Hathaway be if Buffett had raised his own children and loved his first wife more considerately instead of reading so many damn books and annual reports?

To ask may be to answer, but it’s frightening (hopeful?) to think otherwise.

Besides neglecting important obligations and personal considerations, what else do stories like these seem to tell us about those who achieve outsize success?

Incredible stamina seems to be part of it. They don’t just work hard, they work all the time. But again, it’s hard to know if this is part of the person, part of the responsibility and opportunity, or both. How would a person not work hard and often at something they didn’t love to the point they were mesmerized by it? Enthralled is a good way to describe the state of mind in relation to the idea of the thing being pursued here.

Also, simplicity. Maybe it’s the bad ghostwriting designed to break the story down for a lowbrow audience but the way these people talk about what it is they did, they rarely come across as great geniuses, though they’re often wits (Buffett is a notable exception here, and Vanderbilt was clearly “sharp”, a word for cunning back then, though it wasn’t clear he was necessarily “intelligent”, while it was clear he was no buffoon). The grand strategy and complexity is often seen in hindsight, knowing how the story ends and having years and years to tell it and thus accumulate various trappings which may or may not be integral to the success. In Kroc’s own words, it was all about Quality, Service, Cleanliness and Value and then spreading it across the land. Their financing was complicated, but it’s not clear it needed to be, especially if the company was less levered and less insistent on growing as fast as it did. Being focused seems obvious, yet important enough to mention it.

Where does that leave me? If there’s a way to build a legacy that doesn’t involve neglecting one’s family and health, perhaps by being more patient, moving more slowly or being less obsessed about the outcome, that is the kind of legacy I want to build. And I have to wonder what kind of personal insecurity or individual idiosyncrasy or whatever it is, that I seem not to have, that would not allow a person to make that choice given the alternative.

But if the only way to make things great is to trash some other part of your life and leave a smoking crater behind, a crater that’s especially painful in the vulnerability of old age, then I guess I better prepare myself mentally for more humble achievements. I’m just not interested in those kinds of tradeoffs and I don’t understand how such achievements could be satisfying without a family to enjoy them with and the sound mind and body necessary to experience it all.

Following up on my recent review of [amazon text=Good Strategy/Bad Strategy&asin=0307886239], I gave the book a complete re-read and I am now solidly convinced it is a 4/5 title worth the extra effort. There is a lot here to unpack, I ended up taking about five pages of notes as I read and tried to put major concepts into my own words this time around. I am tempted to just copy a list of bullet points but I think that’d be exhausting to read, so instead I will take a fragmented narrative approach.

The Good, The Bad

Good strategy is defined as designing a coordinated and focused group of actions against a critical factor in a given situation (business, military, political, etc.) Bad strategy can be recognized by its hallmarks:

ignores problems or obstacles in the way of intended action

ignores choice or focus in favor of attempting to accede to conflicting demands

A good strategy “selects the path” of how, why and where leadership and determination are to be applied. This path is sketched out with the “kernel”, which consists of three important parts, in this order:

a diagnosis of the challenge to be overcome

a guiding policy describing the area of action to focus on

a set of coherent actions that will be taken to overcome the challenge

A lot of the strength of strategy is gained simply by having a coordinated design for focused action on a single objective, a discipline many competing organizations will lack. Most complex organizations make the mistake of spreading rather than concentrating resources. Leaders need to learn how to say “No!” to a wide variety of competing interests and actions. With focus, one can “use your relative advantages to impose out-of-proportion costs on the opposition and complicate his problem of competing with you.”

Digging in on bad

The author actually has four signposts for bad strategy:

fluff, the illusion of high-level thinking created by manipulating language

failure to face the challenge, providing no way to direct action at an undefined entity

mistaking goals for strategy, stating mere desires rather than creating plans for achievement

bad strategic objectives, sabotaging an effort by impracticality or ignorance of critical restraints

In short, “bad strategy is long on goals and short on policy or action.”

Whereas good strategy seeks simplicity and utilizes heuristics to make complex phenomena understandable and addressable, bad strategy purposefully obscures meaningful dynamics by adding layers and complexity and minutiae to the discussion. Many bad strategies reveal themselves as exhaustive lists of hopes, dreams or things people would like to see done (such as, “Create a strategy for X”, a seeming meta-strategy!)

A strategy must define the primary challenge and the major obstacles to a plan for overcoming it.

Applying strategy

One place to look to for applying strategy is the part of your business that is changing, as there may be an opportunity here to get a jump on the competition. While resource plans are valuable because they ensure resources arrive as needed with expected business operations, they are not the same as a strategy which addresses what is dynamic in an operation. As a strategy is a choice of what goals to pursue, it has implications for sub-goals that permeate the different parts of the organization in order for the main goals to be achieved. But goals themselves are not a strategy, because there are many potential ways to achieve a specific goal; strategy is choosing which path to take and why.

If a strategy can’t bridge the gap between objectives and actions necessary to achieve them, it is merely wishful thinking. Underperformance is a result, not a challenge to be met strategically. Strategy needs to address the specific challenges that result in underperformance as an outcome.

Some common sources of bad strategy:

avoiding the pain of choice; facing the fact that you must displease someone

New Thought; believing positivity and mindset trump all other real factors in a situation

If you propose a strategy and find everyone is immediately bought in, you probably haven’t made a hard choice which suggests you haven’t actually provided a strategy. Strategies have clear winners and losers in terms of existing and potential interest groups.

Revisiting the core of good strategy

To repeat, the strategy kernel consists of three parts, contemplated in order:

a simplifying diagnosis of the problem

a guiding policy directed at obstacles identified in the diagnosis

a set of coordinated, coherent actions to carry out the guiding policy and address the problem

The guiding policy should be aimed at a source of leverage or should build on existing advantages. It needs to address “how” the diagnosis will be treated. The diagnosis itself should call attention to the most crucial facts– on what items does the balance between life or death hang? There are a few ways the guiding policy helps to create advantage:

anticipating actions and reactions (internally and externally)

reducing complexity and ambiguity about how to proceed and what is or is not within the scope of action

exploiting leverage through concentrated effort

building coherence in related actions and decisions so that they serve to reinforce one another

Coherence means that every action strengthens the others and complements them in some way; they do not remain distinct or in conflict with one another. Coherence is the application of centralized intelligence imposed on the “natural” workings of a system. Good strategy imposes only the essential coordination necessary to create large gains, while allowing specialization and decentralization in all else.

Strategic nuances

Foresight diminishes with increased time (uncertainty about the future) to an objective, so proximate objectives are most important when facing the highest amount of uncertainty.

Chain-link systems are one’s whose efficacy is defined by their weakest link. The threshold for improving the system is usually holistic in nature, as the weakest link “shifts” as the system is transformed.

Strategy as a design problem implies the need to make mutual adjustments, resulting in high peaks to gains or sharp costs and losses if wrong. Tighter integration of design requires higher costs/tradeoffs. The degree of integration in a design needed is proportional to the intensity of the challenge faced.

It is human nature to identify current profit with current actions, when really the seeds of present loss and profit were sown long ago.

To identify a company’s strategy, start by examining the business models of competitors. You can also study the business’s policies which are different from the competition and try to think about what that implies about what kind of coordination they’re aiming at.

Forgetting about whether traditional competencies apply to new paradigms is a classic strategic misstep.

Growth, by itself and for itself, is not a strategy. Growth doesn’t create value by acquisition unless you buy below fair value or can increase the value through operational control. Healthy growth usually comes commingled with higher market share and higher profitability as a result of greater cleverness, creativity, efficiency or skill. It can’t be engineered by an acquisition or a merger.

Thinking about competitive advantage

Advantage in competitive settings is rooted in differences which create asymmetries. No one has advantage in everything, so choose your battles wisely.

Competitive advantage is “interesting” when one can find ways to increase its value by creating greater strategic coherence. Having a competitive advantage by itself isn’t valuable because you’re likely to pay a premium to own it, but if you know how to increase or enhance the advantage you gain, then it is valuable to get control of it. Some ways you can increase the value of competitive advantages you possess via strategy include:

deepen the advantage

broaden the extent of the advantage

create higher demand for advantaged products or services

strengthen the isolating mechanisms that block competition

Advantage is deepened by increasing value to the buyer over cost, reducing expenses involved in providing the advantaged product or service, or both. To find ways to reduce costs, start by closely examining how work is being done in provisioning the product or service in question (ie, sources of waste or inefficiency in process).

Extending advantage means using it in new fields and against new competitors. Exploiting a wave of change means adapting your business and organization to where the high ground is shifting to before it can be occupied by others. To recognize industry change, consider these potential forms as guideposts:

incumbent response, successful firms of the old paradigm will dig in and try to resist change

attractor states, think about how the industry “should” work as it moves to a state of higher efficiency

The inertia (unwillingness to change) of rivals can reveal the most effective strategic opportunities. Looking for inertia within your own operation can often result in the same opportunity, if you’re the first competitor to break free of your own orbit! This strategic opportunity is usually centered around renewal and refocus generated by a new guiding policy in a complex organization.

Inertia typically arises due to:

routine, firms can insist on playing by old rules in a new game because it worked in the past

culture, attitudes and behaviors seen as core to the organization’s identity, often masked by complexity

proxy, customer inertia translates into business inertia through still-profitable business lines

In responding to change, don’t make the mistake of building strategies around assumed competencies which aren’t actually present.

Entropy can eat up profitability; de-clutter your organization and operation for increased profitability.

Thinking about thinking

When studying change and theorizing about a response, pay attention to anomalies (situations where experience doesn’t confirm predictions or theories), which represent the frontier of knowledge. Resolving anomalies is where strategic advantage lies.

Improve your diagnosis to improve your strategy. Define problems in need of solutions. Attempt to undermine proposed alternatives to find their weak points. Create a virtual panel of experts and consult with them by imagining what their commentary would be on a specific proposal or circumstance. Pre-commit your judgment in writing to develop the habit of making decisions and not re-rating your analysis after the fact.